What to Know Before You Refinance Your Business Loans

What does it mean to refinance your business loans?

Refinancing a business loan means working with a lender to pay off your original loan in a lump sum and take on another loan with more favorable terms. 

Why would you refinance your business loan?

The goal of refinancing is to make your debt less expensive or easier to manage. This can mean securing a better annual percentage rate (APR), a longer repayment period or lower payments.

The best business lenders don’t want you to drown in debt. They make money when you repay the loan, not if you default on the business loan. For this reason, more manageable terms could benefit lenders and business owners, especially if it means the borrower is more likely to make timely payments.

Some business owners may seek to refinance to consolidate business debt. If multiple debt sources are dragging you down, consolidating your loans into a single source through refinancing can make your financial obligations more manageable.

Pros and cons of refinancing a business loan

Like most business endeavors, refinancing a business loan has pros and cons. Consider these factors before proceeding.

Pros of refinancing a business loan

• Improved cash flow: Lowering your loan payment can help improve cash flow, freeing funds for payroll, inventory, new equipment or other business needs.
• More attractive terms: Refinancing a business loan often results in a better interest rate and more attractive loan terms, which can save you money in the long run.
• Potential for a larger loan: If the loan refinancing improves your cash flow, some lenders may approve you for a larger loan based on your improved debt-to-service coverage ratio. A more significant loan may eliminate the need for additional loans.

Cons of refinancing a business loan

• Lower credit score: Refinancing a business loan can impact your personal or business credit score negatively because it will reduce the average age of your credit. If your score is already low, you may not qualify for refinancing.
• Prepayment penalties: You may incur prepayment penalties for paying off the original loan early, which may reduce the savings you would have earned with refinancing.
• Need for collateral: Some lenders may require collateral as security for the new loan, even if you didn’t put up any to secure the original financing.

Should you refinance your business loan? 

Refinancing is not for everyone. Consider the following to help determine if a refinanced business loan would benefit you. 

You should refinance your business loan if …

• You can get a better interest rate: Refinancing is likely a good idea if the interest rate on your existing loan is high and market rates are now significantly lower. Reducing your interest rate will reduce the overall cost of the loan and can lower your payments.
• You can qualify for a Small Business Administration (SBA) loan: You may be able to replace your higher-interest business loan with a lower-interest-rate SBA loan. SBA loans typically have lower interest rates and can be a better option. 
• You can reduce fees: You may be able to refinance your loan with your existing lender or another lender and enjoy minimal origination and other fees. Even if interest rates are marginally lower, refinancing may be worth it if fees are very low.
• You can pay off credit card debt: You may be able to refinance a business loan to add higher-interest business credit card debt to an existing small business loan. Credit card interest rates tend to be among the highest of all business debt. If you can pay them off by taking out a larger business loan, you can potentially save a lot of money.
• You want to improve short-term cash flow: If you want to invest in growth initiatives and are confident about bringing in enough revenue to pay your expenses, including your loan payments, refinancing for a longer term with lower monthly payments could be a good idea.

You should not refinance your business loan if …

• You won’t receive a better interest rate: If interest rates are now higher than the rate you initially received, refinancing will cost you more than keeping your loan.
• Your credit score has dropped: A lower business credit score means you’ll likely be charged a higher interest rate. In this case, refinancing probably won’t benefit you. 
• You’re close to paying off your loan: Even if the interest rate is much lower than when you took out the loan, it won’t make sense to refinance at the end of the loan term. Loan fees will be expensive, and you’ll probably end up extending the loan’s term, costing you more interest over the life of the loan.
• You want to take on other debt: Refinancing involves a hard credit pull, which lowers your credit score. If you plan to pursue an equipment loan or vehicle lease, you want your credit score to be as high as possible.

Types of business loans that businesses might refinance

Different types of business loans can be used to refinance an existing business loan, including the following:

• Bank loans for debt consolidation: Consolidating or refinancing your business debt through a bank loan may provide a lower interest rate. This type of refinancing is a great way to avoid a balloon payment.
• SBA refinancing: An enhanced SBA business loan is an excellent financing option for small business owners because of the low interest rates and low down payment requirements. A few different SBA loan programs can help refinance your business debt. For example, an SBA 7(a) loan can refinance existing business debt if your new loan has the same security as the previous debt. SBA 504 refinancing is an option for eligible small businesses planning an expansion.
• Alternative loans: If you think you might struggle to qualify for bank loans or SBA refinancing, you can seek refinancing from alternative lenders. Alternative loans include business credit lines and merchant cash advances. For information about an excellent business credit line lender, read our review of Fundbox.
• Term loans: Some private lenders offer highly flexible terms if you want to refinance a business loan to shorten your loan payment term. SBG Funding is a great example (read our SBG Funding review for more information). Similarly, lenders like Fora Financial specialize in short-term loans that are ideal for refinancing. Read our Fora Financial review for more information.
• Equipment loans: If you took out a loan to purchase equipment, refinancing through a business equipment loan is possible. Our best pick on this front is Crest Capital, given its fast funding and low interest rates. Read our Crest Capital review to learn more.
• Microloans: By definition, microloans are small, so they’re a great option if you’re refinancing to lower your loan costs. Accion is an excellent microloan provider — read our Accion review to learn about its flexible terms and unique educational resources.

Costs and fees associated with refinancing

Like all loan types, refinancing incurs costs and fees. Below are some costs and fees you should know about and their percentage of the total loan amount:

• Closing costs: 3 percent to 6 percent
• Underwriting fee: 1 percent
• Origination fee: 1 percent to 5 percent
• SBA guarantee fee: 2 percent to 3.5 percent (of guaranteed amount, not total loan amount)
• Prepayment fee: 0 percent to 2 percent for non-SBA loans; 1 percent to 5 percent for SBA loans with loan repayment terms longer than 15 years
• Late fee: 3 percent to 6 percent

Important things to know before you attempt to refinance

Think you’re ready to refinance? Before proceeding, ensure you understand the following.

1. Not all lenders allow refinancing.

Before applying for a better loan, ensure your original business loan terms include the ability to refinance. Not every lender permits refinancing, so double-check that you can.

2. Your business’s vital signs matter.

Loan terms are based on your credit score, revenue, time in business, cash flow and other indicators of your company’s financial health. You can think of these as vital signs. Have they improved since the last time you borrowed money? If they haven’t, you might want to wait until you’re in a better financial situation to apply for refinancing. Remember that lenders assess your risk as a borrower. If you haven’t proven to them that you’re a low-risk candidate, you’re less likely to find more favorable terms.

3. Know what you want to accomplish with refinancing.

What are you seeking when you speak to lenders? Do you want to find a loan to lower your monthly payments? Are you hoping to extend your current loan’s term? For instance, are you looking to convert a short-term loan to an SBA loan? The best refinancing opportunity for you should align with your business goals.

4. Know your loan’s current terms.

Do you know all the ins and outs of your current loan, including your interest rate? Have you used a debt payoff calculator to assess how much principal and interest you have left to pay off? How is your loan structured? Does it amortize? You get the gist. You can’t find the best refinancing terms to suit your business unless you understand the situation you’re in now — and the one you want to get to.  

5. Not every offer is worth it.

Just because you get an offer to refinance your loans doesn’t mean you should take it. Refinancing is a long process and it’s worth it for the right offer. But if refinancing doesn’t make a big difference for your business, such as making your monthly payments more manageable or giving you access to working capital for a longer period, it might not be worth the trouble. You could be better served by waiting until your financial metrics improve and then reopening your search for solid offers.

How to qualify for a business refinance loan

No two lenders will have the same qualification terms for business refinancing. That said, the notion of a “good borrower” typically includes the same traits, regardless of lender:

• Good business and personal credit history and credit score
• No recent bankruptcies
• No outstanding tax liens
• Certain number of years in business
• High annual revenue with minimal fluctuations

If these traits don’t quite describe you, don’t fret; you can still pursue refinancing. You just might need to sign a personal guarantee. This means the lender can seize your property to repay your loan if you can’t cover it with cash.

Jennifer Dublino contributed to this article.